December 23, 2009

"For much of the past century, America has served as the global model for the power of free markets to generate prosperity…

"In the 2000s, though, the U.S. quickly went from being the beacon of capitalism to a showcase for some of its flaws…

"But one thing is certain: America's success or failure over the next decade will go a long way toward defining what the world's next economic model will be."

One of the article's implied alternatives for the world's next economic model seems a bit of a stretch:

"The troubles in the U.S. stand in sharp contrast to the relative success of other countries, notably China. With a system that is at best quasi-capitalist, China's economic output per person grew an inflation-adjusted 141% over the decade, and hardly paused for the global crisis, according to estimates from the International Monetary Fund. That compares with 9% growth in the U.S. over the same period."

Let's put that comparison to rest right away:

The theory of economic growth is rich, interesting, and somewhat unsettled, but it stands to reason that emerging economies, where the fruit hangs low, can for a time grow much faster than advanced, fully developed countries. Furthermore, I find it reasonable to assume that, contrary to representing an alternative economic model, the Chinese experience over the past decade is itself evidence that even incomplete movements in the direction of free markets can pay large dividends. But even if you doubt that interpretation, the gap between the material circumstances of the average American and Chinese citizen is so large as to make comparisons about the success of the respective economic models premature by several decades.

In fact, the picture above nicely illustrates what I believe is a more on-the-mark observation in the WSJ article:

"At least twice in the past century, the U.S. has re-emerged from deep crises to reinvent capitalism. In the 1930s, the Depression compelled Franklin Roosevelt to introduce Social Security, deposit insurance and the Securities and Exchange Commission.

"After the brutal stagflation of the 1970s and early 1980s, then-Federal Reserve Chairman Paul Volcker demonstrated the ability of an independent central bank to get prices under control, ushering in an age in which powerful, largely autonomous central banks became the norm throughout the developed world."

So what, then, is the alternative model waiting in the wings to replace the current one? It's not given a name, but the features are clear in the article:

"Policy makers' focus now, though, is on the financial sector that failed so spectacularly. Progress has been slow, and key pieces are missing, but the contours of a new system are taking shape. Banks will face stricter limits on their use of borrowed money, or 'leverage,' to boost returns. The Fed will keep a closer eye on markets during booms, and possibly step in to curb excessive risk-taking—a U-turn from its previous policy of mopping up after bubbles burst.

"Such changes would amount to a grand bargain: Give up some of the growth and dynamism of the U.S. economy for a safer, more equitable brand of capitalism—one that could avoid the kind of busts that turned the 2000s into such a disaster."

OK, but here is the central question: How can we be sure that the "new system" will be an improvement on the one it replaces? Some of the most significant failures of the last couple of years occurred in highly regulated industries. So the absence of regulation is not really at issue, but rather what kind of regulation we will have, and how it will be implemented. And there is the obvious point that regulatory change is not really reform if it undermines a system's existing strength. Some of the reform proposals on the table, for example, have the potential to seriously compromise "the ability of an independent central bank to get prices under control," the very feature of our current system that the article identifies as an historical source of resilience.

"There are many cracks in the financial system, some of which we now know, others no doubt we will discover down the road.… A common theme of our proposals notes that fixing all the cracks will shore up the financial house but at great cost. Instead, by fixing a few major ones, the foundation can be stabilized, the financial structure rebuilt, and innovation and markets can once again flourish."

One of those major cracks is the "too-big-to-fail" distortion. Is it important to remember that too-big-to-fail is itself a creation of regulation, not markets? I think so.

By David Altig, senior vice president and research director at the Atlanta Fed

TrackBack

TrackBack URL for this entry:http://www.typepad.com/services/trackback/6a00d8341c834f53ef01287678fb21970c

Listed below are links to blogs that reference :

Comments

This was very interesting, but I think you made the question too narrow.

"Too-big-to-fail" is not a creation of either regulation or markets per se. It was created by cornering the market for regulation. The new model involves changing the regulations in this meta-market, via campaign finance and other procedural reforms to our democracy.

Yes, Yes, Yes, all of us know what the term regulatory capture means. Who's gonna regulate the regulators? Have fun chewing on that one..

The fact is so very few people really understand how the machine works. I won't even pretend I do. The history of the machine is that when it breaks, it's like the human body. Doctors rush in to prescribe this and that, but often it self heals.

So, take two aspirin and call us in the morning would be my advise.

However I do thing something structurally did change. What it is, I do not yet know. But I see it's sign and footprint all over California.

Great post. As far as regulation of the financial sector, I think that the fix supplied by both Congressional committees, and the thoughts of the Treasury Secretary are misguided.

They are not changing anything.

I would rather see regulation based on function in the marketplace. For example, many activities the SEC deems "legal" are very anti-competitive and anti-free market. For example, payment for order flow and the internalization of order flow. These two practices don't make the market more efficient, but certainly line the pockets of the big banks that can practice them.

I'd like to see a ban on dual trading. If you want to be a broker, then get paid to broker your customers' order. Otherwise, take risk and be a trader. There is a huge conflict of interest that has been exploited by specialists, investment banks and others for years. Secondly, I'd ban payment for order flow, and internalization. Also, the reporting of trades is nebulous. A block trade is reported late. They should be reported in real time to give better information to the market.

All the proposed trading taxes working their way through Congress will hurt markets as well.

I certainly can sympathize with the Americans who decry the greed on Wall St. However, the regulations currently in place don't allow for markets to nip a lot of that greed in the bud, and the new proposed regulations will do nothing to curb it either. We are rebuilding the same house of cards.

Post a comment

Please submit appropriate comments. Inappropriate comments include content that is abusive, harassing, or threatening; obscene, vulgar, or profane; an attack of a personal nature; or overtly political.

December 18, 2009

October data indicate financial stress continuing to ease

Update: The numbers for T-bills and notes/bonds I am quoting refer to net official purchases only, not total net purchases by foreigners.

Original post:

The October Treasury International Capital (TIC) data, which report on U.S. cross-border financial flows, suggested continued unwinding of a massive flight to quality that took place in financial markets in the second half of 2008. (For a detailed overview of U.S. cross-border financial flows during the recent crisis, see a comprehensive report from the Federal Reserve Board.)

Cross-border private capital flows, which plummeted at the peak of the financial crisis in fall 2008, resumed as risk aversion in financial markets started to abate. On net, foreign private investors have again become buyers of U.S. assets, which has helped to increase the supply of capital in the United States.

Based on the TIC data, it appears that U.S. investors, too, are now channeling their savings abroad by buying foreign bonds and equities. Last fall as the global economy fell into a deep recession, U.S. investors sold, on net, foreign assets and repatriated capital at a record pace, partly offsetting outflows of foreign private capital. In recent months, U.S. investors on net bought foreign equities and bonds as foreign economic growth resumed and conditions improved in financial markets. The renewed purchases of foreign securities by U.S. investors shown in the data, however, represent an outflow of capital from the United States and, all else equal, increased U.S. reliance on foreign financing.

The TIC data also show the easing of financial stress, which is reflected in the recent pick-up in foreign net buying of riskier U.S. assets, such as equities, and an increasing demand for agency bonds, including agency mortgage-backed securities, from foreign private investors. Also, foreign investors are rebalancing their portfolios from U.S. Treasury bills to longer-term Treasury securities.

As the financial crisis intensified in the fourth quarter of last year, foreign official investors bought on net a record $181 billion in Treasury bills while on net they sold $23.4 billion in Treasury bonds and notes. Although emerging markets' official reserves fell in the fourth quarter of 2008 (their central banks were selling dollars to support local currencies), net selling of longer-term Treasuries and a sharp sell-off in agency debt funded a surge in net buying of U.S. Treasury bills, based on the TIC data. Similarly, private investors' net buying of treasury bills soared in the second half of 2008. Buying short-term Treasuries allowed a shift to quality and safety in the most prudent way, leaving open the option to quickly reverse the flow. Now that the crisis has subsided, foreign official investors have tapered their purchases of Treasury bills and have increased their purchases of longer-dated Treasuries while private investors began on net selling Treasury bills in second quarter of this year.

Despite all these improvements, the influence of the financial crisis is still evident in the data that show persistent net selling of agency bonds by foreign official investors that began last year as well as continued net selling of long-term corporate debt by foreign private investors.

By Galina Alexeenko, economic policy analysis specialist in the Atlanta Fed's research department

Let me also add that I see net ADDITIONS of treasury bonds/notes in the fourth quarter of last year. Net purchases by foreigners was $32.872, -$25.815 and $14.97 billion in October, November and December respectively. Am I missing something?

Post a comment

Please submit appropriate comments. Inappropriate comments include content that is abusive, harassing, or threatening; obscene, vulgar, or profane; an attack of a personal nature; or overtly political.

December 11, 2009

Better news on the jobs front: Layoffs down, temp hiring up

November's employment report released last week provided significantly better-than-expected numbers on the jobs front. Payroll counts declined by 11,000 last month—the smallest decline in two years—and job losses in September and October were revised down a considerable 160,000. The declining number of job cuts is showing up in some other data, too.

First-time claims for unemployment insurance have shown a clear downward trend since last spring (though there was an unexpected increase during the first week of December). Claims have fallen by 200,000 since peaking in March, dipping by roughly 25,000 in the weeks following the payroll survey alone.

While the trend is better, fewer layoffs do not necessarily translate to job creation. On average, the jobless had remained unemployed for a record 28.5 weeks in November. Tuesday's Job Openings and Labor Turnover Survey (JOLTS) reported another record low hiring rate in October and a continued decline in the number of job openings.

However, even in today's weak labor market there are signs that some hiring is going on, even if it is temporary. The American Staffing Association's (ASA) staffing index has temporary hiring trending up since July 2009. The U.S. Bureau of Labor Statistics payroll survey showed the temporary help sector started posting gains a month later, adding a net 117,000 jobs in the four months through November.

In the coming weeks, the ASA index will shed more light on the evolution of temp demand ahead of the December payroll report. Temporary employment is typically regarded as a leading labor market indicator—the intuition being that firms tend to hire temps or increase the hours of current employees before committing to permanent workers. The combination of fewer layoffs and more hiring provides some welcome news—but within the context of two years of job losses.

By Laurel Graefe and Menbere Shiferaw, both Atlanta Fed senior economic research analysts

Comments

It's hard to see how the economy can recover with the government doing its best to make it as inefficient as possible. How does repaving roads over and over again with money earned by real people doing real jobs help? Coming soon - higher taxes, higher interest rates. Hard to see how that is going to stimulate anything.

this is a good development. I am closely watching how long the hourly work week is. I have also unsubstantiated anecdotes that tell me China is not what it seems. They are producing, but the production is going into a warehouse. No demand for products.

A lot of the data from September to November appears to be skewed better than the normal seasonal pattern as a result of the the sudden fall-off in the economy last fall and winter. The total level of employment appears to have roughly stabilized since January when the majority of layoffs went into effect. The growth in the labor force is continuing to add to unemployment.

Seasonal adjustments using 2008 continue to skew the data wildly. This week's IUC came out 109,000 below the raw number of claims. The next two months may be even more skewed considering that the NSA nonfarm employment fell by 3.6 million in one month from December 2008.

Post a comment

Please submit appropriate comments. Inappropriate comments include content that is abusive, harassing, or threatening; obscene, vulgar, or profane; an attack of a personal nature; or overtly political.

"The Obama administration expects the cost of the Troubled Asset Relief Program to be $200 billion less than projected, helping to reduce the size of the budget deficit, a Treasury Department official said yesterday.

"The administration forecast in August that the TARP would ultimately cost $341 billion, once banks had repaid the government for capital injections and other investments. Congress authorized $700 billion for the program in October 2008."

There is precedent for such good news. Travel back for a moment to the formation and operation of the Resolution Trust Corporation (RTC), the agency formed to purchase and sell the "toxic assets" of failed financial institutions following the savings and loan crisis of the 1980s. As noted in a postmortem by Timothy Curry and Lynn Shibut of the Federal Deposit Insurance Corporation (FDIC), the cost projections for the RTC ballooned in the early days of its operations:

"Reflecting the increased number of failures and costs per failure, the official Treasury and RTC projections of the cost of the RTC resolutions rose from $50 billion in August 1989 to a range of $100 billion to $160 billion at the height of the crisis peak in June 1991..."

In the end, however, the outcome, though higher than the very first projections, came in well below the figures suggested by the worst case scenario:

"As of December 31, 1999, the RTC losses for resolving the 747 failed thrifts taken over between January 1, 1989, and June 30, 1995, amounted to an estimated $82.7 billion, of which the public sector accounted for $75.6 billion, or 91 percent, and the private sector accounted for $7.1 billion, or 9 percent."

While people may debate the approaches taken, it is heartening to see evidence that TARP, like the RTC before it, is ultimately costing considerably less than estimated.

By David Altig, senior vice president and research director of the Atlanta Fed

Comments

Since the expressed purpose was to 'save Main Street' by handing out the future to Wall Street, the plan has decidedly not worked. Main Street has been pulled through the knothole anyway, and paid for the experience.

Please. Give us a break. What about trillions of dollars in guarantees given to various institutions. How about junk MBS paper bought by the federal reserve and GSE's. Lets not pretend that the cost to tax payer is going to be minimal. This is going to end badly but only for the tax payers. The banks will make out like bandits.

Interesting. An interview I read with Kashkarian had him stating that "700 billion" was a number pulled out of thin air. They had no idea how much to ask, so they decided to ask for as large a number as they could get.

I am glad they didn't go over it. However, I am dismayed at the outcomes learned. The government now wants to create more bureaucracy to oversee the financial system. The TARP has created even more concentration-bringing with it anti-competitive oligopolies.

The banks also received massive tax breaks in the stimulus which are inflating the value of the shares that were exchanged for cash from the government. There's a good article in todays Washington Post.

Post a comment

Please submit appropriate comments. Inappropriate comments include content that is abusive, harassing, or threatening; obscene, vulgar, or profane; an attack of a personal nature; or overtly political.

December 04, 2009

Read the fine print

You might casually read that headline and assume that the Federal Open Market Committee was mighty impressed by the November employment report—and quick to respond with the first stages of a reversal in the stance of monetary policy. The facts lie, however, underneath the headline.

At issue are so-called "reverse repo" operations, described in the article thus:

"In a reverse repo, the Fed sells securities with an agreement to buy them back later at a higher rate…

"Reverse repos are one tool the Fed has at its disposal when the economy and financial markets have improved enough for it to drain cash from the system. The Fed uses short-term repurchase and reverse repurchase agreements to temporarily affect the size of the Federal Reserve System's portfolio and influence day-to-day trading in the federal-funds market."

On Thursday, the New York Fed conducted $180 million worth of reverse repo transactions on, as the article points out, "the heels of a series of reverse repo tests that have been done by the bank over recent weeks." That word "tests" is the key:

"The Fed earlier this week said it would implement small-scale reverse repos over coming weeks but said the operations have no implication for monetary policy. Rather, the Fed said the operations are being conducted to ensure operational readiness at the Fed, tri-party repo clearing banks J.P. Morgan Chase and Bank of New York Mellon, and primary dealers, the lead group of banks that deal directly with the central bank…

" 'The idea is they want to get all their ducks in a row and be ready (to pull cash) when the time is necessary,' [RBC Capital Markets interest-rate-strategy group head Ira] Jersey said, adding that there's no point in doing large scale reverse repos as long as the Fed is still purchasing assets."

A better headline for the article would surely have been something like "New York Fed Starts to Lay Groundwork to Unwind Stimulus When Time Comes." It doesn't exactly sing, but it represents the facts.

By David Altig, senior vice president and research director at the Atlanta Fed

TrackBack

Comments

David I am fascinated with all the hoopla over the exit strategy. As I see the QE contains its own exit strategy, albeit a slow one. In that mortgage-backed securities are in and of themselves self-liquidating (principle and interest)and have an imbedded call option (moving or refinance)the balance sheet will eventually shrink. Indeed if the economy returns to 6+ million in existing home sales the process may occur at an ever increasing rate.

I am thinking it might night be as hard as people think to sop up the extra cash that is in the market. It isn't in the economy, it is sitting on bank balance sheets. Large matched sale transactions, not accepting non-traditional types of collateral, and rising the discount rate a little might do the trick.

Post a comment

Please submit appropriate comments. Inappropriate comments include content that is abusive, harassing, or threatening; obscene, vulgar, or profane; an attack of a personal nature; or overtly political.

Jobs and the potential commercial real estate problem: Still keeping us up at night

Reaffirming last month's call that the Great Recession is over, NABE [National Association for Business Economics] panelists have marked up their predictions for economic growth in 2010 and expect performance to exceed its long-term trend. "While the recovery has been jobless so far, that should soon change. Within the next few months, companies should be adding instead of cutting jobs," said NABE President Lynn Reaser, chief economist at Point Loma Nazarene University.

While we at the Atlanta Fed agree that the recession has likely ended, we wish we could feel as optimistic about the current jobs outlook. We've catalogued those concerns before—here, for example—but we continue to look for reasons to believe that our pessimism is unwarranted.

"… reduced bank lending may well slow the recovery by damping consumer spending, especially on durable goods, and by restricting the ability of some firms to finance their operations."

Among the factors restricting lending, "… with loan losses still high and difficult to predict in the current environment, and with further uncertainty attending how regulatory capital standards may change, banks are being especially conservative in taking on more risk," Chairman Bernanke said.

One area where bank loan losses are potentially high and uncertain is commercial real estate (CRE). As highlighted in a macroblog post from October, if the CRE problem falls disproportionately on financial institutions that also finance small business activity, we will be all the more worried that "the post-recession employment boost [small] firms typically provide may be less robust than in previous recoveries."

In fact, as Atlanta Fed President Lockhart noted in a speech last month, as of mid-2009 the banks with high exposure to CRE (relative to tier 1 capital) accounted for about 40 percent of commercial and industrial (C&I) loans to small businesses.

Underneath that statistic are a couple of additional facts that also have our attention:

Over time, CRE loans have become increasingly concentrated in those banks whose CRE lending activity is high relative to their available capital. As of June 2009, banks with CRE loan books more than three times their Tier 1 capital level accounted for 52 percent of the $1.6 trillion of CRE loans in bank portfolios. Though this is lower than the 2008 peak of 59 percent, it compares to just 17 percent in 1993.

Small businesses that rely on bank loans for credit are much more likely to be affected by a bank's CRE exposure than in the past. In 1993, banks with CRE loan books more than three times their Tier 1 capital accounted for just 11 percent of total small business C&I loans. But this share increased to 42 percent in 2008 and stood at 38 percent in June 2009 (of a total of $281 billion of C&I loans to small businesses).

The following chart summarizes these two observations.

Thus, both commercial real estate loans and small business C&I loans are much more concentrated in banks with relatively lower levels of capital than has been the case in the past. Combined with our previous observation that a relatively high fraction of small business loans sit in banks with significant exposures to commercial real estate, these facts do not strike us as a case for optimism regarding the near-term outlook for growth in small business borrowing.

Perhaps today's job summit will result in additional ideas to counter what we see as a serious drag on job creation in the near term. And, of course, tomorrow's employment report could show signs of improvement in labor markets. That would be good news.

By David Altig, senior vice president and research director, and John Robertson, vice president, both in the Atlanta Fed's research department

Comments

Doesn't this lead you to a rationalization that there needs to be a change in market structures so that institutions are not "too big to fail"? If commercial lending risk is associated with few banks, then isn't there a concentrated time bomb waiting to go off?

It seems as though the Dodd bill, and the Frank bill do nothing to correct this problem. They merely load us up with more bureaucracy and limit the power of the Fed.

Unemployment was slightly better today-but I fear that the seasonal adjustments YOY from last November skewed the number. The situation was pretty dire from November 2008 to March 2009, and I think you can pretty much throw out all stats YOY for comparison.

Commercial real estate is poised to default in record numbers by the accounts of many. Many commercial loans are on 3-5 year notes and the notes that are coming due cannot be supported due to a lack of income caused by lower rents and in some cases no rents at all.

Yes there probably will be record defaults, but it will probably be no where near as bad as it could have been. Most of the banks started to set up special teams almost a year ago to deal with it. Keep your fingers crossed that it works.

commercial real estate loans and small business C&I loans are much more concentrated in banks with relatively lower levels of capital than has been the case in the past.
Most of the banks started to set up special teams almost a year ago to deal with it...very interesting article, i agree with jeff either..

Post a comment

Please submit appropriate comments. Inappropriate comments include content that is abusive, harassing, or threatening; obscene, vulgar, or profane; an attack of a personal nature; or overtly political.